What Happens When Banks Are Feeling Lending Constraints

Equity Residential, one of the biggest apartment landlords in the United States, normally finds refinancing its bank loans to be easy. This year, it was a longer journey.

For the company’s $2.5 billion backup line of credit, known as a revolver, lenders have historically treated the refinancing process like a formality or an administrative task, CFO Robert Garechana said in an interview. This time, there were many more discussions, often focusing on what business banks would get from the company in return, he said.

“You could feel the constraints that the banks are facing,” he said.

Lenders weren’t worried about Equity Residential’s overall financial health, Garechana said. S&P Global Ratings grades the company’s main unit at A-, solidly in the category of investment grade. But revolvers tend to generate low fees, so banks view them mainly as a way to win more profitable business like bond underwriting.

Many banks have been thinking harder this year about which companies they should extend these kinds of loans to, as the Federal Reserve hikes rates and the threat of a recession looms. Demand for credit is still relatively high: U.S. commercial banks have seen their loans outstanding rise about 7 percent since March, according to Fed data.

But the lenders also face more risk, and regulators have been pressuring them to carefully consider what their capital requirements will be in the future. The Fed gives annual stress tests to see how banks will perform in times of economic and market difficulty. This year’s tests resulted in unexpected boosts to capital cushion requirements for banks including JPMorgan Chase & Co. and Citigroup Inc.

In addition, some large banks are facing higher capital requirements due to a different type of buffer related to their status as global systemically important financial institutions, said Alison Williams, a senior banking analyst at Bloomberg Intelligence. “In a very short time, they had to shore up their capital to get above those new requirements, so they became more disciplined with their terms around commercial lending to conserve their balance sheet ahead of these increases,” Williams said.

Many banks have now met the current requirements, so the pressure on corporate lending could ease for the rest of the year, Williams said.

For Equity Residential, it was clear that banks are considering their broader capital requirements and asking more questions before lending to corporations, according to Garechana. “If we’re having these level of conversations, it has to be much harder for non-investment grade, or lower quality investment grade companies,” Garechana added.

Representatives for Bank of America Corp., which served as administrative agent on the revolver, and JPMorgan and Wells Fargo & Co., which participated as joint bookrunners, declined to comment.

According to Garechana, the banks cited three overall reasons for their extra caution. The first is that a stricter regulatory environment has increased capital requirements.

The second reason is that banks have gotten more requests for loans in recent months. Many companies that couldn’t borrow at reasonable rates in the investment grade or junk bond markets decided to get bank loans instead, which has tied up lenders’ balance sheets. In addition, the market for packaging real estate loans into bonds and selling those to outside investors has cooled, meaning banks have had to hold more of those loans themselves.

And the third was that some foreign banks, especially those without local dollar deposits, find it harder to commit to lending in the United States because the greenback is so strong relative to their home currency.

According to public filings, two international banks based in other countries dropped out of the revolver during the refinancing process: French bank BNP Paribas SA and Japan’s Sumitomo Mitsui Banking Corp., a unit of Sumitomo Mitsui Financial Group Inc. In addition to BNP and SMBC, U.S. regional bank Fifth Third Bancorp also left the group. Garechana said the company still has a good relationship with the banks and that there were “no bridges burned.” In the end, 19 banks were on Equity Residential’s latest revolver in October.

Representatives for BNP and Fifth Third declined to comment. A representative for SMBC didn’t respond to requests for comment.

Everybody Wants Cash

Banks are thinking about capital, but many corporate executives are as well. Real estate billionaire Sam Zell, the founder and chairman of Equity Residential, said in an interview with CNBC on Thursday that he’s holding more cash and sees a recession as likely. He discussed the challenge of refinancing the revolver as well.

One piece of evidence that banks weren’t worried about Equity Residential’s credit quality was the fees it’s paying on the refinanced loans. The real estate investment trust is paying 12.5 basis points (bps) annually just to have the revolver, the same as before. For money it does draw on, it pays 72.5 bps over the Secured Overnight Financing Rate (SOFR). That compares with 77.5 bps over the London interbank offered rate (LIBOR) on its previous loan. The company also added a sustainability-linked feature.

—With assistance from James Crombie & Patrick McHale.

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